The Two Branches of Macro-Economic Theory

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The Two Branches of Macro-Economic Theory

Introduction

Perhaps the most divisive area of economics when applied to macro- economists and political decision making can be considered to be the field of Macro-economics. It is critical since it often leaves the two divided into different schools of thought. Since the end of World War II the economic landscape has been dominated by ideas of Friedrich von Hayek and John Maynard Keynes. These influential economists both had distinct ideas about economic freedom that are in contrast to each other but they have contributed significantly in shaping the global economic landscape. With this overview the article will seek to expand more on the Keynes and Hayek ideas, while also analyzing how they impacted different policy makers.

Policies that Keynes and Hayek advocated

According to the Keynesian ideology of the economy they believe that the decisions often made by the private sector lead to the macroeconomic outcomes being inefficient. Therefore, the theory advocates for public sector early policy responses that include fiscal policy interventions by the government and monetary policy actions by the central bank to stabilize economic output over a business cycle (Caldwell, 1998).

On the other hand Friedrich von Hayek, ideology believed that the free market price system is an efficient system that can effectively coordinate people’s actions, and in addition due to the gradual spontaneous orders over time due to the economic exchanges between people the markets are created. Hayek believed that any interference with the spontaneous order of free markets would distort their efficient operation since they were highly organic in nature.

The main difference between the two ideologies include Keynes suggesting that when it comes to markets that it is necessary for government to intervene, while Hayek believes in little if any government involvement since he advocates for a free market. On monetary policy Keynes believes it plays a major role in aggregate demands and stimulating the economy. Keynes’ solution rather focuses on government spending. In opposing this Hayek is rather adamant on the monetary policies, since he believes that boom bust cycles are results of its implementation. After a recession Keynes suggests fiscal policy to help the pump to prime recovery, where the economy is propped up through the government stimulus packages. Such interventions are opposed by Hayek on the grounds of preventing interference on the market processes. Hayek on the other hand is strongly opposed to such interventions (Cochran, 2011).

With the above analysis of the two economists, I believe the one Hayek proposes is more ideal, since according to him the free reign or less government interference grants more economic freedom, and with that choice the economy would be more efficient. I can argue that there is no economic calculation under a central planning and from this perspective their decisions would not be effective in utilizing the resources, since there initially never was a system to price the alternatives. Meaning the central planners cannot make economic decisions only technical ones, and this makes Hayek more viable.

Why it will affect the US

Some of the main reasons that made people believed the U.S would be affected include facts like the financial markets being linked, and this means that whatever is happening in the financial markets in Asia could directly affect the U.S markets. American companies and banks are significant investors and lenders in the region, in terms of U.S company’s subsidiaries, bank loans and financial instruments investments and this would affect the economy. The U.S. exports and imports were also being affected by the turmoil, as well as the value of the U.S. dollar, and the countries capital flows. These all directly affected the U.S. economy making people come to that conclusion.

Dealing with 2008 crisis

It was important for the Congress and Fed to coordinate fiscal and monetary policy measures to address the 2008 recessions, since through their integration they expanded the countries fiscal policy which intern affected the rate of inflation and consequently increased the aggregate demands in the economy. This affected the entire government capacity due to the new monetary policy stand to finance the budget deficit by expanding or limiting the available sources of financing and by the cost of the debt service which all helped address the 2008 recession.

Comparison of the Rationale of the tax cuts

The 1964, Kennedy-Johnson tax cut, the 2001 George W. Bush tax cuts and the 1981 Reagan tax cut, if compared all show that it can be costly to a country to implement an ideological approach to the tax cuts without first taking its broader economic circumstances into account.

According to economic indicators on the 1964 Kennedy-proposed tax cuts they suggest that even though they apparently had a down side, they were still effective and they helped with the revitalizing the economic thus justifying its implementation. The stagflationary economy that President Ronald Regan inherited, acted as the basis for his implementation for taxes cut in 1981 that over the next three years took effect, even though they also recorded a good growth response to the tax cuts and addressing the inflation a common factor between these two cases is that they were too generous even though their conditions were prime for the tax cuts, even with the robust growth of the economy there was still increase in national debts and persistent high deficits.

By 2001, as George W. Bush took office the GDP were slowed down by the previous government’s expansions, therefore, the economic case for tax cuts wasn’t overly compelling. Due to this Bush saw that the Americans needed tax cuts since they were being overcharged. The Bush tax cuts presumably were meant to reignite growth in the U.S. without affecting its employment and position fiscal, which later dramatically deteriorated (Sanz-Bas, 2011).

This analysis shows that if the rational for a tax cut is right and it is properly designed like in (Kennedy-Johnson), it would have positive impact. On the other hand if it isn’t well calibrated but it still has right context (Reagan) it often leaves mixed results regardless of the justification. If the design and economic context aren’t both right (Bush) it would be disastrous to justify implementing a tax cut.

Conclusion

From the experience of the Great Depression, economists learned much, and today most economists advocate for governmental roles in creating economic stabilization policies. Although economists may disagree about timing or strength of the tool to be used or on which particular tool is most appropriate most economists however recognize the advantages of using monetary and fiscal policy for the prevention of depression and extreme inflation in the economy.

References:

Caldwell, B. (1998) Why didn’t Hayek review Keynes’s General Theory, History of Political Economy, 30:4.

Cochran, J. P. (2011) Hayek and the 21st century boom-bust and recession-recovery, The Quarterly Journal of Austrian Economics, Vol. 14: 3.

Sanz-Bas, D. (2011) Hayek’s critique of the general theory: a new view of the debate between Hayek and Keynes, The Quarterly Journal of Austrian Economics, Vol. 14: 3.